The key criticisms of ETFs is that you only ever get market returns.
If the market goes up by 6%, your ETF will go up by 6%. It would be nice to able to beat the market but still get the benefits of investing in ETFs right?
Well, fear not. A bunch of smart investment folks have created special ETFs aiming to improve on the ordinary ETF – they call them “Smart Beta ETFs”.
What are Smart Beta ETFs?
Traditional ETFs replicate an index (i.e. the ASX 200). They weight their investment holdings based on the market capitalisations of the companies. This means larger companies have disproportionate impact on the ETF’s performance. For example, the big 4 banks make up ~40% of the ASX 200, so their performance is a major driver to any ETF that tracks the ASX 200.
The factors to determine their selection can vary, ranging from sales volume, cash flow, dividend payout ratio, etc. Essentially, each type of Smart Beta ETF gives you an opportunity to skew index investing with a specific investment strategy.
Smart Beta ETFs in Australia
There are many types of Smart Beta ETFs. In Australia, we can group them into three broad categories:
1.Ethical: ETFs that screens out non-ethical companies from an index. Examples include UBS IQ MSCI Australia Ethical (UBA) and Russell Australian Responsible Investment ETF (RARI)
2.High Dividend: ETFs that focus on high dividend paying companies from an index. Examples include SPDR MSCI Australia Select High Dividend Yield Fund (SYI) and Betashares S&P 500 Yield Maximiser Fund (UMAX)
3.Strategy: ETFs that only pick stocks fitting a specific investment strategy. For example, the Russell Australia Value ETF (RVL) invests in companies within the ASX 200 index but weight the fund based on their “value characteristic” rather than by market cap.
How effective are Smart Beta ETFs?
A Smart Beta ETF is effective if it delivers on its intended investment strategy. For example, a high dividend ETF should deliver high dividends but still achieve returns similar to the index.
Let’s look at two types of Smart Beta ETFs and whether they are effective in delivering the stated strategy.
High Dividend ETFs
There are more than 5 ETFs that looks to provide an Australia Share portfolio with high dividends. For ease of comparison, lets only look at iShares’ IHD and Vanguard’s VHY.
In comparison, IHD and VHY had dividend yield of 6.85% and 7.79% respectively. Good start so far. But on a total return basis (i.e. price returns plus dividends), IHD and VHY only achieved -2.09% and -3.98% respectively. The ASX 200 achieved 2.56% total return for the year.
In comparison, IHD and VHY had dividend yield of 6.85% and 7.79% respectively. Good start so far. But on a total return basis (i.e. price returns plus dividends), IHD and VHY only achieved -2.09% and -3.98% respectively.
The ASX 200 achieved 2.56% total return for the year.
Turning to ETFs that invest with a strategy in mind. We selected three ETFs for comparison:
- UBS’s ETF that looks to replicate the ASX but screening for stocks using UBS investment banks’ proprietary research;
- Russell’s RVL that looks to replicate the ASX but screening for stocks that have good “value”;
- Market Vector’s MVW that invests in large ASX listed companies with 50% revenue from Australia and weighted equally.
The obvious goal here is that using these strategies, you can achieve a better return than the index.
Key take away
Like all investments, there are no guarantees. Smart Beta ETFs cannot always perform better than the index. But, it is clear that most Smart Beta ETFs are great at achieving their core objectives or strategy. For example, the high dividend ETFs do generate higher dividends than the overall index.
In this sense, if you have a specific investment strategy in mind, maybe a Smart Beta ETF can help you achieve them.
This is a guest post from BetterWealth – an online ETF portfolio builder to help you create and manage an ETF portfolio.
M.TaxFP, LLB(Hons), B.Bus(Acc), FTI, Adv.DipFP, Dip.FP, SMSF Specialist
The information on this blog and website is of a general nature only. It does not take into account your individual financial situation, objectives or needs. You should consider your own financial position and requirements before making a decision. We recommend you consult a licensed financial adviser in order to assist you.